USD/CAD: Trading the Bank of Canada Interest Rate Decision

Trading the News: Bank of Canada Interest Rate Decision

What’s Expected
Time of release:        12/08/2009 14:00 GMT, 09:00 EST
Primary Pair Impact :    USDCAD
Expected:         0.25%
Previous:         0.25%

Impact the Bank of Canada Rate Decision on USDCAD over the last 2 meetings

October 2009 Bank of Canada Rate Decision

The central bank in Canada kept the benchmark interest rate at the record-low, and held a weakened outlook for future growth as policy makers anticipate the marked appreciation in the exchange rate to ”more than fully offset” the recent rebound in economic activity. As a result, the Bank of Canada reiterated borrowing costs are likely to remain at 0.25% throughout the first-half 2010 as “heightened volatility and persistent strength in the Canadian dollar are working to slow growth and subdue inflation pressures,” and went onto say that the board maintains “considerable flexibility” in the management of monetary policy even as the key rate remains at its lowest level since the central bank was established in 1934. As the BoC talks down expectations for higher borrowing costs, the pull back in the interest rate outlook may weigh on the exchange rate going forward as investors weigh the prospects for future policy.

September 2009 Bank of Canada Rate Decision

The Bank of Canada held borrowing costs at the record-low and said that “growth in the second half of 2009 could be stronger than the bank projected in July” as policy makers pledge to kept the interest rate at 0.25% going into the following year. However, the BoC said that the “persistent strength” in the domestic currency continues to pose a threat to the recovery, and went onto say that it maintains “considerable flexibility” in managing policy even as the interest rate remains at its lowest level since the central bank was establish in 1934. Moreover, the board went onto say that the economy has “evolved largely as expected” throughout the first half of the year, but reiterated that they expect price growth to hold below the 2% target for inflation until the second quarter of 2011.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to go long the USD against the Canadian dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on USDCAD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the USD against the Canadian dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on USDCAD ahead of the data release.

How To Trade This Event Risk

The Canadian dollar is likely to face increased volatility on Tuesday as the Bank of Canada is widely expected to keep the benchmark interest rate at the record-low, and the central bank may hold a dovish outlook for future policy as the marked appreciation in the exchange rate continues to hamper the prospects for a sustainable recovery. A Bloomberg News survey shows all of the 19 economists polled forecast the BoC to hold borrowing costs at 0.25%, while investors are pricing a zero percent change for a rate hike according to Credit Suisse overnight index swaps as Governor Mark Carney pledges to hold the key rate at its current level throughout the first-half of the following year. Nevertheless, the world’s eighth largest economy emerged from the recession in the third quarter, with the growth rate expanding 0.4% from the three-months through June, while the nation added 79.1K jobs in November, which unexpectedly pushed the annual rate of unemployment to 8.5% from 8.6% in the previous month. Moreover, retail spending advanced 1.0% for the second consecutive month in September to top forecasts for a 0.6% rise, while housings starts increased to 157.3K in September from a revised 149.3K in the previous month, and conditions are likely to improve over the coming months as the expansion in monetary and fiscal policy continues to feed through the real economy. However, business spending grew at a slower pace in November as the Ivey PMI slipped to 55.9 from 61.2 in the month prior, while consumer prices unexpectedly weakened 0.1% in October, and the central bank may take additional steps to encourage a sustainable recovery as the board anticipates inflation to hold below the 2% target until the third quarter of 2011. Governor Carney said that the central bank has “options” to temper the appreciation in the exchange rate during a speech in front of the Senate banking committee, which includes quantitative and credit easing, and noted that the “slack” in the economy is likely to keep price pressures subdued throughout the following year. At the same time, former BoC Governor David Dodge said that monetary policy could “remain accommodative through 2015” as the government aims to balance public finances, but went onto say that the central bank could move away from “unconventional initiatives” as growth prospects improve. As policy makers aim to stem the downside risks for growth and inflation, investors may scale back long-term expectations for higher borrowing costs as the central bank holds a dovish outlook for monetary policy, and a pull back in the interest rate outlook is likely to weigh on the exchange rate as the board continues to see a risk for a protracted recovery.

Trading the given event risk may not be as clear cut as some of our previous trades as economists anticipate the BoC to hold borrowing costs at the record-low but nevertheless, price action following the rate decision could set the stage for a long Canadian dollar trade. Therefore, if the central bank holds an enhanced outlook for growth and inflation scales back its dovish rhetoric, we will look for a red, five-minute candle following the release to generate a short trade on two-lots of USD/CAD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance, and this risk will establish our first target. The second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to lock-in our profits.

In contrast, the continued appreciation in the domestic currency paired with increasing fears of a protracted recovery may lead the BoC to hold borrowing costs at the record-low for an extended period of time, and comments following the rate decision could drag on the exchange rate as investors weigh the outlook for future policy. As a result, if the central bank turns increasingly dovish and sees a risk for growth and inflation to weaken over the following year, we will favor a bearish outlook for the Canadian dollar, and will follow the same strategy for a long dollar-loonie trade as the short position mentioned above, just in reverse.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com